Entrepreneurship Part III: The Most Important Hurdle

Venture capitalists are investors, and all investors have a hurdle rate.

Their money is tied up in different assets: cash, stocks, bonds, real estate, foreign currencies, commodities, etc. Those assets are earning them returns. The returns could be

  • interest paid on cash deposits or bonds,
  • dividends paid on shares of stock,
  • rent paid on real estate, or
  • capital gains earned from the sale of many assets, including currencies and commodities.

The returns are generated

  • at a particular rate
  • over some amount of time and
  • with a certain level of risk.

For example, cash in a savings account is almost guaranteed to return a small amount of interest from the bank (less than 5% annually) and a large amount is guaranteed by the FDIC never to be lost. Purchase of a foreign currency might return a large amount when it is sold, but there is a good chance the investor may actually lose part of his or her investment.

The investor expects a certain rate of return from his or her current holdings. For an investor to move money into a new venture, the venture must promise a superior rate of return. This minimal rate of return is called the hurdle rate. It is not rational an investor to invest money with an entrepreneur unless the entrepreneur’s venture can exceed the investor’s hurdle rate.

Have you heard of the hurdle rate? Do you think about it in your own investments? Feel free to post comments and questions below.

Tags: Business, Economics

Updated at: 12 February 2009 11:02 AM